Global Gold Production & the Aussie Gold Sector
Source: Neil Charnock, GoldOz (3/1/11)
"This gold bull is younger than you might think. . ."
At the same time, the exploration expenditure that has been stimulated by higher gold prices is starting to result in some interesting new discoveries that can impact the growth of emerging producers significantly. These emerging producers also offer exploration upside from Greenfield and Brownfield targets due to increasing cash flows and increasing exploration budgets.
Before we can analyze forward projections for gold and gold stocks we have to understand the past and the present in some detail.
The lack of world-class discoveries points to an increasing supply deficit in addition to resource replacement issues for the majors over coming years. New gold deposits of any decent scale (+10 Moz.) have become harder to identify in recent years. These large-scale discoveries have been in steep decline since the late 80's. Even smaller 1–10 Moz. deposits are also being discovered less and less since that time. At the same time the massive debt overhang (still growing—read money printing) in the "first world" and strongly increasing investment demand over recent years is expected to provide additional demand for gold.
Now add decreasing production as a factor. This is partly due to the cut-off grade response as larger companies feed lower grade ore into production in order to lengthen mine life. Average mined ore grades have decreased by 30% since 1999. Just to balance this analysis—you would also have expected mines still operating at US$250 per ounce gold to have been increasing their grade back in 1999 just to stay afloat. This 30% grade reduction equates to a rise in cash costs of around $150 per ounce.
Cash costs are a very important indicator however this metric should not be our fixation here because this does not reflect the total cost. Total cost of gold production was up at US$690 across the industry in 2008 and at $717 in 2009. These figures reflect a more accurate view of the real cost of developing and maintaining production. As large new discoveries become scarcer this cost will rise further.
Of course, this is an average and the larger mines that are developed at large scale deposits tend to produce at lower cost. The lowered incidence of finding these large scale deposits means that larger mines are slowly losing their over dominance of total production. Now we face the necessity to mine smaller and smaller deposits to meet rising global demand. Should mine profit margins fall into negative territory we would once again lose incentive to explore and develop these smaller mines. This would exacerbate the supply imbalance further. It seems likely that if massive deposits remain difficult to find the majors will be forces to scale down and be willing to bring smaller deposits into production. As we are forced to go deeper (e.g. South Africa) or to lower and lower grades, to smaller and smaller deposits then the price of gold has to continue to rise. A look back over historic gold production is both interesting and necessary at this point if we are to consider the big (production) picture a little better.
Production has changed greatly since 1970; back then, South Africa produced 2/3 (about 30 Moz.) of the world's measured gold production of 47M ounces per annum (PA). By 1985 this had increased to around 50 Moz. PA and production in South Africa had dropped off to around 21.5 Moz. Global production was rising particularly in Canada, the USA, Brazil, China and Australia. By 1990 heap leaching technology had been introduced liberating gold from lower grade ore bodies and assisting global production to around 75 Moz. PA. The US and Australia raced ahead to about 12.8 Moz. and 10.6 Moz. respectively as the Soviet Union broke up. Bulk mining methods allowed huge low grade oxidised deposits in dry climates to be exploited and new areas were opening up to explorers in Russia, Latin America and Africa. This trend continued into 2000 before the effect on new global production started to reduce.
By 1995, South Africa produced just 16.75 Moz., the US approached the level of the former USSR at over 10 Moz. and Australian production was rising sharply at 8.2 Moz. hitting over 10 Moz. PA by 1997. Countries like Ghana, Indonesia, Chile and Peru saw production levels of around 2 Moz. PA increasing their share of the total world production, which was around the 1990 level.
By the turn of the century, gold production was truly global as miners had searched the world for several years looking for higher grade mines and lower production costs. The lag effect from discovery to production had reached a crescendo. The top three national producers were still South Africa, the USA and Australia however these three now produced just 41.8% of global production. This is also when gold production peaked at over 2,570 metric tons PA, which is over 82 Moz. PA. Then things began to change dramatically once again. The demand for and price of gold started to rise and production started to fall. Exploration had dropped off dramatically due to the shocking economics of gold production.
By 2005, global production was back to 2518 metric tons and Australia was the second largest national producer. International investors may note that the weakness in the AUD worked for gold miners back around 2000 as the AUD gold price was still up over $500 per ounce. This may account for an extra strong showing by producers in Australia at the time. The US was back to number three and China was launching their gold production up over 220 metric tons PA. South Africa was back under 12% of global production after being up at over 16% five years earlier. Demand was soaring with new demand from China as they opened up their retail infrastructure. There were other changes afoot—that were soon to escalate the price of gold to new levels, capable of stimulating production.
The Australian dollar price of gold only took off near the end of the first half of 2005. So did our gold sector with a vengeance as all gold stock investors that were around at the time remember vividly. By 2008, gold production was still falling as South Africa continued to produce less and less. China was number 1, the USA number 2, Australia number 3 and South Africa number 4. Production is now much more evenly spread with Peru, Russia, Canada, Indonesia, Uzbekistan and Ghana all contributing strongly to global production—which was reduced to just 2350 metric tons.
In 2009 global gold production finally rose slightly back up to 2570 metric tons on the back of rising Chinese production and even wider participation on a global basis. That also meant production was falling in other leading nations due to the reasons above; mining of lower grades and failure to bring on new large discoveries. Demand from risk adverse investors was still soaring and central banks became net buyers. central bank sales almost halved in 2008 and fell to 30 metric tons PA in 2009 after running at 400—500 metric tons a year between 1989 and 2007.
This was a significant shift in the fundamental picture for gold and it was expected by those investors that had done their homework. We know the central banks selling was not sustainable and that gold was a valuable component for the central banking system as a hedge against currency volatility. The global financial system was in dire need of stability mechanisms due to systemic imbalances across the board.
This reduction in supply from the central banks was equivalent to a 16% fall in global production by itself. Total global production circa 2500 metric tons and Central bank sales of 500 metric tons comes to a total of 3000 metric tons. 500 tons from 3000 tons is about 16% which is massive. Mining companies have reduced forward sales, called hedges, as well.
Hedging created forward paper sales of massive amounts of unmined production in the mid to late 90's. Some analysts claim that this, combined with central banks sales created a false low in the price of gold. I am one of these analysts as I am always looking for price distortions that can be exploited. In my view gold would never have gone below US$400 an ounce without central bank selling and forced hedging by financial institutions.
In this case, the miners were also exploited however and many were lucky to survive at all. Having lived and run mining businesses through such rough times these gold miners are very well justified to be angry about any talk of any super profits tax. They, like farmers for instance are entitled to enjoy some good years when they finally arrive, reap the benefits and put something away for the lean years in future.
The thing to remember is that, if some of us are right, that gold would not have fallen below US$400 per ounce without central-bank selling and the sale of paper gold hedges (unmined gold,) then this gold bull is younger than you might think. Bubble propaganda states that we are up over 5x from US$250 however this is barely over 3x from US$400 to US$1400. In Australia we bottomed at around AUD$550 around the year 2000 are at $1400 now for a rise of under 3x. So what? This gold run is just getting started and the mania stage is still far enough away for us to accumulate a larger and larger portfolio with the right strategy.
When you factor in the rising demand for gold, which surpassed 3,800 metric tons in 2010, you get a compelling argument for a substantial upside for gold price—and China is just getting started. They are importing ever larger volumes of gold and silver creating a sustainable demand curve. When China's disposable income class recognises rising inflation and economic risk to a greater degree this can rise rapidly and significantly.
The official sector, governments and central banks will continue to hold gold as a valuable part of their reserves. They are probably more risk adverse than the average investor because they understand the challenges in the financial system better. So where does this all leave us? Rising demand from several sources, rising need and awareness, stuck production levels and higher production costs has to equal a steadily rising gold (and silver) price.
Our analysis indicates that, correctly managed, we still have greater upside from investing in the mining companies. We do recommend some physical metal as part of your strategy, however, not to hold the metal at home. There already have been some home invasions and theft of precious metals, so even a safe is not safe. Store the metal in safety and spread it around different institutions—no matter what the cost. It is worth it for the sake of your own personal safety.
The gold stocks are extremely fluid in that takeovers, mergers, mishaps, new projects and discoveries make the sector more difficult to follow. The rewards for doing so however far outweigh the time consumed by the process. If you are busy this ongoing work can be purchased for as little as $1 per day. Due to the nature of the industry and how the index components change on a regular basis I am rapidly giving up on any index analysis of this type.
We are just not measuring apples against apples in the indexes any more due to de-listings from the ASX (such as Centamin), major mergers (such as Newcrest and Lihir) and new entrants to the indices. This market has become one where you have to play stocks on an individual basis and I view this as a good thing. It makes it much harder for novice investors however the good news is that despite the strong run in gold in AUD terms since 2005 there is still some low hanging fruit. We can still identify stocks that represent major upside for investors, stocks I expect to go up five to tenfold over the coming three years purely due to organic growth.
We are monitoring a number of the more promising stocks (at current prices) in an Ideal Portfolio to show the gains in real time. We also include investment rationale and timing theory as put to the test. We are also monitoring the sector by individual stocks and have added a few new producers, developers and explorers of value lately. I believe this is the best approach for capital growth.
We measure the performance of these stocks quarter on quarter in our ratings tables and, therefore, have followed the progress of the producers and developers very closely. High gold and silver prices are driving the industry to perform and it is meeting the challenge to the delight of shareholders. There is much talk of a gold mania and I do believe that the banking and political systems make this inevitable over the coming years. The optimum way to protect yourself and grow your wealth is to hold on for the ride and to constantly do your due diligence on these companies to follow their progress.
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Neil Charnock is not a registered investment advisor. He is an experienced private investor who, in addition to his essay publication offerings, has now assembled a highly experienced panel to assist in the presentation of various research information services. The opinions and statements made in the above publication are the result of extensive research and are believed to be accurate and from reliable sources. The contents are his current opinion only, further more conditions may cause these opinions to change without notice. The insights herein published are made solely for international and educational purposes. The contents in this publication are not to be construed as solicitation or recommendation to be used for formulation of investment decisions in any type of market whatsoever. WARNING share market investment or speculation is a high risk activity. Investors enter such activity at their own risk and must conduct their own due diligence to research and verify all aspects of any investment decision, if necessary seeking competent professional assistance.