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Gold's precipitous decline in the first half of 2013 sent shockwaves
throughout the entire mining industry.Its scary panic-induced 28% plunge over
just six months has forced the miners to revisit their development plans.And
this will no doubt have an adverse impact on global mine production in the
years to come.
It's actually quite fascinating to observe how quickly things have changed
for the miners in response to 2013's decisive move countertrend to
normalcy.And in gold's case, normalcy had been a fundamentally-backed consistent
and healthy uptrend in its price (2012 was gold's 12th-straight
calendar year with a price increase).
Interestingly 2013 wasn't expected to be any different as far as the
miners were concerned.Gold's structural fundamentals
were still spectacular.And though in 2012 its price was never able to revisit
2011's all-time high, it was a year in which gold sported its highest-ever
average price ($1669).Given these conditions the miners were poised to do
what they did best, produce gold, make money, and plow capital into
developing their pipelines.
But alas, this year hasn't quite been as hunky-dory as hoped.And the
earliest and most transparent effect of the sharply-falling gold price has
been seen in the miners' financials.With gold's average price in the first
half of 2013 $150 lower than 2012's ($250 lower in Q2), margins have
obviously been squeezed.And this has resulted in a lot less money being made
from existing operations.
Gold's much-lower prices are also forcing the miners to take huge
write-downs and impairment charges (some projects are no longer economically
viable, and others must be re-valued to the market).In the second quarter
alone major miners Barrick Gold, Newmont Mining, AngloGold Ashanti, Goldcorp,
Newcrest Mining, and Kinross Gold announced over $23 billion in
combined write-downs and impairments.
Given gold's consistent rise, most miners had been valuing their assets
using prices on the high side of an interim range.They just assumed that
gold's price would continue to rise, and that the prices they used would
eventually be conservative.Gold's recent action has vanquished this mindset
though.And these same miners are now nervous about the values of their
assets.Unfortunately I suspect we'll see a lot more write-downs and
impairment charges in the quarters to come.
These accounting phenomena are non-cash, paper losses.And while they are
tough to swallow in whatever quarter they show up on the income statement,
they can be even more damaging from a sentiment perspective.And unfortunately
sentiment takes an even bigger hit when there's a systemic issue across the
entire sector.
Ultimately the barrage of financial reckonings in the recent quarter has
left a bad taste in investors' mouths.And the miners' stocks have greatly
suffered as a result.It's been one of the worst stretches for gold
stocks in this entire secular bull market.
So with gold prices and stock prices way down, the miners have suddenly
found themselves in a sentiment wasteland.And in this wasteland the future
doesn't look as bright.The folks that run these companies aren't as confident
in gold's future as they were six months ago.And with less cash flow and a
much-more-challenging financing environment, their spending plans are not
feasible anymore.
For these reasons and more, most miners have been forced to revisit their
development plans.And in many cases this has resulted in the delaying or
outright shelving of expansion/development projects, as well as a huge
cutback on exploration.The miners are now in capital-conservation mode, and
this will no doubt have a major adverse effect on future production volume.
This will of course be a shame considering all the work put into the
gold-mining infrastructure over the last decade or so.Interestingly it was
only just in 2009 that the miners finally got ahead of the depletion
curve.Years of aggressive development led to the first material increase in
global mine production in quite some time.
And this was the beginning of a healthy streak, with 2012 being the fourth year in a row of
production growth.The miners delivered a record 2700 metric tons to
the market.But this hard-won streak is now in jeopardy as a result of gold's fluky panic.If indeed
the miners curtail development and shut down higher-cost operations,
production volume has nowhere to go but down.
And this production decrease could play out sooner than we think.In the
World Gold Council's latest Gold Demand Trends report, it states "While
mine production historically has been slow to react to changes in the price,
the extent of the fall in the second quarter has elicited a swift response
from gold producers. Recent spending cuts and the closure of costly
operations across the industry may start to have an impact on the supply
pipeline by the end of this year."
By the end of this year?!?Wow!This is a crazy-fast reaction by an industry
where reaction is typically slow and methodical.Gold's 2013 panic sure did
scare the miners, which is readily apparent by the tone of their recent press
releases.They are now positioning themselves so they don't get caught with
their pants down again.And I believe the result will be prolonged lower
production levels driven by three distinct phases, closure, delay, and
backfill.
Closure is the first and most immediate phase that will negatively impact
production.Within this phase are two methods of closure.The first is full
closure, the outright cessation of all mining operations.If a mine can't make
money at lower prices, it will be shut down.This shutdown is usually
temporary at first, with the hope that higher prices would again make it
economically feasible.Regardless of downtime, this is production that comes
right off the market.
The next kind of closure is a partial closure, or source closure.Some
mines run multiple mining methods, multiple ore types, and/or multiple
processing circuits.If one is not economically feasible at current prices,
it'll be shut down.And this would obviously reduce output.
Some mines also blend material, meaning lower-grade ore is mixed in with
the higher-grade stuff.At lower prices many mines won't be afforded this
luxury.So rather than just increase the higher-grade material (which would
drastically reduce the mining life), most miners will simply stop running the
lower-grade material to reduce operating costs.This would get them back in
the money, but again volume would be down.
Closure is something we are already seeing today.And we'll likely see more
at operations that just can't turn a profit at lower prices.Interestingly
analysts have recently been estimating that all-in sustaining costs for the
industry average around $1200.If this is the average, then the
topside outliers are in big trouble.
In the onset of 2013 most of us expected another record production
year.But with closures mounting, this may not come to fruition.Reductions in
output from this first phase may just be enough to offset new volume from
some big operations that came online earlier this year.And when you compound
closures with development delays, we're almost certain to see less mine
production in 2014 and beyond.
Development delays have been the talk of the town.As publically-traded
companies, the miners must keep investors in the know regarding any material
decisions.And there's been a throng of announcements over the last couple
quarters that have outlined radical alterations to numerous miners' tactical
and strategic plans.
From a tactical perspective we're seeing a lot of mining companies rein in
spending for the remainder of the year.And while it may not seem like a big
deal, it actually is.Whether pulling drill rigs from the field, holding off
on equipment ordering, or anything else that would slow the advancement of a
project, this type of activity delays future production.
From a strategic perspective, we're seeing some miners outright suspend
development plans they had in the works.This includes both expansions at
existing mines, as well as brand-new mine development.As you can imagine,
this development is crucial for sustaining current production levels.Mines
are constantly being shut down due to depletion and/or economic viability,
and there naturally needs to be a steady flow of new development to replace
the production that's being lost.
Unfortunately a degree of paralysis has gripped many miners as a result of
the shock from seeing the economics of their development projects radically
change over such a short period of time.Some projects are flat-out uneconomic
at lower prices (these are the ones being written off), and the rest have
IRRs and NPVs that are well lower than anticipated.
Sadly this paralysis is preventing many miners from pulling the trigger on
development, even if their projects still have positive economics.And these
delays are mostly financially driven.The miners are either conserving capital
out of fear that gold prices may go lower, or they are concerned over their
ability to fund these developments.
Over the last four years, new development has stayed ahead of
depletion.But it won't take many development delays to fall behind the
curve.And if the delays already announced hold true, then there will no doubt
be a negative impact on future production levels.
The final phase of future production pressure will be a product of
insufficient backfill.As mentioned depleting/closing mines need to be
replaced by a constant flow of new development.And it is a strong pipeline of
development-stage projects that allow for this to happen.
In order to maintain a strong pipeline of development-stage projects
though, there needs to be a steady flow of discovery and advancement at
earlier-stage projects.These projects are the ones that backfill the
development projects when they are removed from the pipeline.And if there's a
shortage of them, it will eventually be felt on the production side of
things.
I truly believe it will be the lack of backfill that will smack the
gold-mining industry the hardest.Not only are the large producers cutting way
back on their exploration spending, the junior sector has all but ceased
exploring and advancing projects.I discussed the huge crisis of confidence
currently strangling the junior sector in a previous essay.And it's not hard
to conclude that a lack of activity in this realm will adversely impact
global mine production in the years ahead.
Overall gold's 2013 panic makes a global mine-production decline
imminent.And I suspect this will be the case even if June's low holds and
there's a quick reversion to the mean.The damage has already been done.And
regardless of gold's price, the miners will be gun-shy on the capex front for
some time to come.
Declining production obviously has huge implications for investors,
especially if demand remains high.Since mine production is by far the largest
source of supply, a decline would create a supply-side economic
imbalance.More money would be chasing after less gold.And this is actually
quite bullish for the price of gold, as it must rise until a balance is met.
As gold climbs higher, the miners should also attract investor interest.Those
that have survived and thrived in 2013 will take a leading role in the next
leg of this metal's secular bull.The producers will be well positioned to
leverage their profits, and the junior explorers with quality projects to
feed the pipeline will sell for a hefty premium.
At Zeal we believe we're in the early stages of a major gold upleg.We've
thus been loading up on gold stocks amidst the panic and its aftermath.And
we've already seen some excellent unrealized gains on many that we've
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The bottom line is 2013's infamous gold panic will prove to be a
game-changer on the supply front.It really freaked the miners out!So
much so that we're already seeing huge spending cuts and mine closures.
We're also seeing an onslaught of suspensions and delays in the
development projects that are supposed to replace depleting operations in the
near and long term.And to top things off, exploration is at a near standstill
as the miners seek to conserve capital.This will lead to an imminent
production decline, which will ultimately be bullish for the price of gold in
the years to come.
August 30, 2013
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Thoughts, comments, or flames?Fire
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will read all messages.Thanks!
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(www.ZealLLC.com)
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