Factors Influencing Global Gold Mine Supply

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Global gold mine production rose very sharply between the early 1980s and 1990s. Through the middle of the 1990s mine production growth stagnated and was actually flat in 1995. There was then some recovery in the period 1996-1998, but output contracted in 2001 and 2002 as the effect of several years of low gold prices took its toll. Even as gold prices rose throughout the first decade of the 21st century, annual gold mine production fell in most years. It wasn’t until 2009 that this trend reversed. Exploration activity and the acceleration of development of gold mines picked up in the past decade and only now have begun to manifest in refined supply growth. There is typically a lag between the rising price of a metal and its impact on mine supply, because of the long lead times associated with bringing a new mine onstream. Global gold mine production is estimated to have reached 80.9 million ounces in 2012, up around 2.6 million ounces or 3.3% from 2009 levels. The rise in gold prices since 2002 is expected to result in gold mine production continuing to rise over the next several years.
The most important factor influencing mine supply is the price of the underlying metal, especially in relation to the cost of mining. Gold prices have been in a rising trend since 2002, following a period of flat to declining prices since the middle of the 1990s. The strength in gold prices since the early 2000s attracted rising investment in gold exploration. Dollars allocated to gold exploration rose on a year-on-year basis in all years between 2002 and 2012, except for 2009. The decline during 2009 was a result of the global recession that began in 2008 and financial constraints that hit gold exploration and mining companies. Gold prices had continued to rise in 2009, however. As a result funds allocated to gold exploration declined by 27%, compared with a decline of 50% in total funds allocated to other nonferrous exploration budgets (the term nonferrous excludes iron ore, aluminum, coal, oil and gas). This difference in the magnitude of decline between gold exploration budgets and other nonferrous exploration budgets highlights the importance of the underlying metal’s price and its impact on exploration spending.
During 2012 the total global nonferrous exploration budget is estimated to have reached a record high $21.5 billion, according to Metals Economics Group. This estimate is an 18% increase over 2011 levels. It is likely that around 46% of this total, or $9.9 billion, was directed toward gold exploration, which would be an increase of around 7.6% from 2011 levels. An estimated $46.3 billion was allocated to gold exploration between 2002 and 2012. Increased exploration and development expenditures for gold over the past several years have resulted in several major projects expected to come onstream over the next several years. The estimated dollars allocated to gold mine exploration was a record high in 2012. The rate of growth in dollars being diverted toward the gold mining industry was at its lowest in ten years (barring 2009). The rate of growth could slow further over the next several years.
The gold mining industry is faced with two important challenges, an increase in operating cash costs and a flat to declining medium-term price outlook.
Cash costs at gold mining operations continued to rise for the tenth consecutive year, during 2011. The production weighted average gold cash cost was estimated at $628 for 2011. This was an increase of around 16% over 2010’s gold cash cost. As of 2011, cash costs have risen around three times their 2002 levels. Cash costs have continued to rise during 2012, reaching $733.46 during the third quarter of 2012.
There are two distinct sets of factors driving average cash costs higher and lower at mines. The first set of factors relates to the actual costs of inputs: Skilled labor, professionals, equipment, and everything else that goes into running a mine. The second set of factors relate to the price of the underlying product of the mine. As the price of gold rises, miners work higher cost properties, on average. As the price of gold falls, they cut back at higher cost mines and the average production cost declines.
The price of the metal also affects the input costs, the other set of factors affecting cash costs. When the prices of metals are low, people cut back on developing and running mines. The costs of skilled geologists, mining engineers, financial experts in mining, miners, drillers, drill rigs, hauling trucks, explosives, concentrator reagents, and there materials needed to run a mine tend to soften, if not decline. When metals prices are high and there is a rush to develop new mines and either expand or reopen old ones, the demand for these inputs rises, driving their costs higher. Cash costs typically rise in response to increases in the price of the primary metal being mined. The strong correlation between gold prices and gold mining cash costs can be explained by producers bringing onstream and restarting high cost mines when prices rise, and shuttering high cost properties when prices decline. There are marginal mines that have particularly low grades, may be in difficult mining regions, or have high costs for other reasons. Increases in gold prices allow producers to justify mining higher cost deposits, covering the increased costs associated with these mines. The rising price of gold has as a result been largely responsible for the increase in cash costs that we have seen over the past decade.
The largest component of cash costs is labor. Typically this cost accounts for around half of the mining cash cost. This component of cash costs has been on the rise and is one of the primary reasons for the increase that has been occurring in gold mining cash costs. The increase in labor costs can be partially attributed to a shortage of skilled workers in the entire mining industry and partially to the high price of gold which results in all workers demanding a higher wage or salary.
Despite these sharp increases in gold mining cash costs, the margin, on a nominal basis between the average cash operating cost and annual average price of gold has risen from $114 per ounce in 2002 to $941 per ounce in 2011. Based on the average cash cost and gold price for the first three quarters of 2012, the margin between these two metrics was $927 per ounces. At a $114 margin on a cash cost basis, before adding in other overhead, financial, and administrative costs, producers could not justify building new mines, let alone continuing to operate some higher cost, unprofitable mines. Thus, mine production was declining at that time. Today, mining companies on average are enjoying a profit margin in excess of 100% on a cash cost basis, making a lot of properties formerly undeveloped or closed a great deal more attractive to operate.
Even as costs have risen sharply over the past several years the cash cost in dollar terms is still low relative to the price of the metal, as can be seen in the margins being enjoyed on average by the gold mining industry. These costs have remained low relative to the price of gold for a couple of reasons, low cost ore processing techniques such as leaching and that a majority of gold mining is open pit.
When the price of the metal being mined rises, miners are quite often willing to mine lower grade ore. This is because the high price of the metal compensates for the lower grade. Typically, lower grades do have a negative impact on cash costs, because of the increased inputs required to recover a relatively smaller amount of metal. In the case of gold, however, the use of leaching technology allows for recovering gold from lower grades relatively cheaply. This has helped to keep operating costs from spiraling higher on this count.
Input costs are higher in the case of underground mines compared with open pit mines. This is because these mines are larger consumers of electricity, require more skilled labor (resulting in higher labor costs), and require more equipment and steel compared to open pit operations. South Africa is a good case in point of these higher costs resulting from deep level mining. That said, a majority of the gold mined is from open pit operations, which helps to keep the global average cost of production lower.
The development of open pit mining as a major form of gold mining since the early 1980s has been a major factor in both driving down average production costs and reducing the grade of ore being mined.
With regards to the price of gold we expect prices to remain at historically elevated levels during 2013, but the price is unlikely to breach the 2011 record high in 2013. On an annual average basis, gold prices are forecast to average $1,650. Gold could over the course of the year trade as low as $1,450 and could potentially rise as high as $1,800.
Investors still see many reasons to hold at least some portion of their wealth in gold, but they do not intend to chase the price higher. The lack of urgency results from the fact that many of the problems that are cited as reasons to purchase gold — such as debt and deficit issues of governments around the world, the weakening of major currencies, monetary accommodation by central banks — are already factored into the price. These are structural issues which are expected to take years to be resolved, and it is becoming increasingly clear to investors that the doomsday predictions related to these issues are unlikely to materialize. Investors thus continue to add gold to their long-term portfolios against long-term economic difficulties, but they have become more price sensitive.
Going forward gold mine supply is forecast to continue rising in the medium term in response to the sharp increase in prices over the past several years. Margins between cash costs and the price of gold also are still very healthy on an industry average basis. This should continue to support an increase in supply. Costs have risen over the past several years and are forecast to continue rising. A healthy medium-term outlook on the entire mining industry should increase the demand for various mining inputs keeping upward pressure on costs. This would squeeze margins between cash costs and the price of gold, given the expectation that gold prices are likely to consolidate over the next few years, albeit at elevated levels. The tightening of margins could result in some high cost producers rejigging their operations and some producers reconsidering their capital expenditure. This could potentially affect the long-term mine supply of gold.
Rohit Savant is a Senior Commodity Analyst at CPM Group. CPM Group is an independent commodities research and consulting firm headquartered in New York. For information on CPM Group’s services and research, contact info@cpmgroup.com or Matt Taub +1 212 785 8320.
Source : Bullion Bulletin

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