January 14, 2014 5:57 pm

Gold mining: Squandered opportunity

Investor demands for restructuring and an end to the old approach of sprawling expansion are growing

In the vast open pit at Goldstrike, electric shovels 20 metres tall crunch easily through the rock of northern Nevada. Three scoops fill a truck that hauls off 300 tonnes of gold-bearing ore, while underground teams nearby bore richer deposits at 25 metres a day.

The site, excavated over almost three decades, set Barrick Gold on its way to becoming the world’s largest gold miner. Yet more than 9,000km to the south, at a mine the company hopes will one day be as successful, things are very different.

Pascua Lama, 5,000 metres up in the Andes straddling Chile and Argentina, has been blighted by cost overruns and environmental disputes. Barrick has written off more than $5bn on the incomplete project: engineers are now putting it into what might be a long hibernation until the gold price – and the Canadian company’s balance sheet – recover.

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IN Analysis

The tale of two mines epitomises the profound change in fortunes for the gold mining industry. Barrick and its peers once enjoyed premium valuations as eager investors anticipated outsized returns from a climbing gold price. Profits flowed easily from the likes of Goldstrike’s 2m ounces of annual production in pro-mining and accessible jurisdictions such as Nevada.

Now, mishandled investments and bloated projects have taken the shine off gold miners, which in recent years have generally underperformed the metal itself. Peter Munk, the Canadian entrepreneur who built Barrick, steps down as chairman this year with a shadow cast over the end of his career by his company’s problems.

Deutsche Bank says the four largest North American gold companies – Barrick, Newmont, Goldcorp and Kinross – are worth less than in 2006, when gold was half today’s price of around $1,245 per oz. The value of AngloGold Ashanti, the South African miner that is the world’s third-largest producer by output, has fallen by more than 40 per cent over the same period.

Further disappointments await. Some of the world’s largest gold miners are expected soon to announce cuts to the reserves they calculate are in the ground, acknowledging that millions of ounces of ore are no longer economic to mine as the gold price has tumbled.

For some investors, this is more than just an inevitable turn of the commodity price wheel of fortune in a cyclical industry. They hope 2014 will bring a fundamental rethink of the “big gold” model that created sprawling companies such as Barrick and Newmont – each producing more than 5m oz of gold annually – while doing little to satisfy shareholders.

“We need to see a cleansing of the sector that allows companies to ’fess up to the mistakes they have made and reset the dial,” says Evy Hambro, co-manager of the BlackRock World Mining Trust. “Many gold companies have been growing for the sake of growth, often financed with share issues – and that has ultimately watered down returns for investors. Companies have been going backwards rather than forwards from an investor point of view.”

Some miners are still gunning for growth. This week Goldcorp, which has come to rival Barrick as the world’s most valuable gold miner, unveiled a hostile C$2.6bn bid for Osisko, a Canadian rival.

For others, the need for change has been more urgent. Barrick raised $3bn in equity in November to shore up its finances by paying off part of its load of debt. Many analysts expect other gold miners to try to come back to markets for more cash – a tall order if investors have lost trust.

Moreover, this is the first crisis to envelop miners since most abandoned hedging, and following the creation of exchange traded funds in gold – simple instruments that have given many investors the exposure they want to the metal without the complications and risks of holding companies’ shares. Companies could face even frostier times ahead unless they can restore faith that, through growth or dividends, they can provide returns that are better than can be obtained from simply holding gold.

Neil Gregson, a fund manager at JPMorgan Asset Management, says miners became lazy in the way they ran their businesses as the price of gold rose 600 per cent in the first 11 years of the century. “They thought that the gold price would always save them,” he says. “They lost touch with their operations.”

Some problems of the gold sector afflicted the whole mining industry over a decade when prices for most commodities rose strongly. As companies scrambled to take advantage by increasing output, the race to expand drove up costs, particularly for salaries of experienced staff and for equipment. It also prompted companies to accelerate more marginal projects, confident that the price would offer support.

“Costs went up far more quickly than anyone realised. No one had their head around the cost inflation until it was too late,” says Joe Foster, a portfolio manager at Van Eck International Investors Gold Fund.

In all mines, rising prices induce miners to exploit more marginal areas of lower ore grades. Digging more dirt with each ounce of metal inevitably adds to operating costs.

These problems are compounded in gold mining. The precious metal is not abundant and deposits are usually smaller and more quickly exhausted than base metals. As gold miners have grown, they have had to run ever faster and harder to replace the ore they have dug out of the ground each year – with limited success. According to SNL, a data provider, some 800m oz was added to global gold reserves and resources in the decade and a half up to 2012 – but 1.2bn oz was mined during that period.

Nor has the quality of reserves been maintained. Mark Bristow, chief executive of Randgold Resources, says the grade of reserves has gone from 2.6g per tonne in 2000 to about 1.1g/tonne, meaning mining will be costlier.

Mr Foster at Van Eck says: “There is a natural limit to the size of a gold company. You just don’t find many mega deposits in mother nature, which is one reason why the supermajor model does not work for the gold industry.”

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With few big new deposits in easily mineable areas, the bigger miners have had to compensate. One obvious way has been by acquisition – such as Kinross buying Red Back Mining for $7.1bn, or Newcrest, Australia’s largest gold miner, buying Lihir of Papua New Guinea for $9.5bn, both in 2010. Yet buying reserves, rather than finding them through exploration, is expensive and can stretch management capacity, while economies of scale are limited. Mr Hambro says: “There are no real synergies in being bigger if you have one deposit in Australia, a second in Brazil and a third in west Africa.”

Alternatively, miners can plough ahead with big, eye-catching projects, often in riskier locations, such as Barrick’s Pascua Lama. But larger mines require more cost and time between discovery and production.

Deutsche’s Mr Beristain believes bigger miners, with access to cheap capital, have been taking too many risks with large-scale projects, while increasing the likelihood of falling victim to “resource nationalism” – the desire of governments to get a greater share of revenues from mining.

For example, Barrick and Goldcorp had to bow last year to demands in the Dominican Republic for a renegotiated agreement over their Pueblo Viejo mine, a key project for both companies. This month Goldcorp said its effective tax rate had increased from 29 per cent a year ago to 41 per cent as a result of the Pueblo Viejo deal as well as a tax rise in Mexico.

. . .

Companies’ overly rosy assessments of their costs of production have unwittingly raised expectations for governments – and investors. By focusing on day-to-day operating costs, gold miners glossed over spending on starting projects or keeping mines running smoothly. Many miners belonging to the World Gold Council, an industry group, have now started publishing their “all-in sustaining costs” of production – revealing little scope for returns to investors at current prices.

Companies are cutting costs. But other changes require more fundamental attention. One solution advocated by investors is that companies break themselves up.

Smaller units might be nimbler and cheaper to run – notably the salary bill for top executives – and more “under the radar” for governments and NGOs opposed to mining development. The $12m share package given to John Thornton on becoming co-chairman at Barrick in 2012 was a lightning rod for investor discontent.

Gold Fields, one of Africa’s largest producers, unbundled some South African operations into a company called Sibanye Gold in 2012. Barrick has also hived off a subsidiary called African Barrick Gold, although its attempts to sell the UK-listed unit have foundered. A small hedge fund, Two Fish Management, last year called for Barrick to unbundle more regional business units.

A second idea is that gold miners should diversify. Barrick bought Equinox, a copper producer, in 2011 and Newmont is seeking deeper exposure to copper. Gary Goldberg, Newmont’s chief executive, says the premium valuation that gold miners once attracted will not return, so there should be no penalty for diversifying.

Another mining chief executive says: “If investors gave us credit for it we’d all like to be mining other metals because it makes sense not to have all eggs in the same basket. Our core competencies are digging and infrastructure and logistics and so it doesn’t matter so much what exactly we are digging.”

The problem is that investors are cool on the idea. Mr Foster calls it “another syndrome of being a supermajor” for the likes of Barrick and Newmont. “They know that they can’t grow in gold so they are looking at non-gold alternatives. But as a gold investor I won’t be interested. Gold is a unique asset class and people buy gold companies for their gold exposure,” he says.

Some stronger miners still see opportunities to grow. Even without any deal for Osisko, Chuck Jeannes, Goldcorp’s chief executive, expects output to be more than 40 per cent higher in 2017.

Other, weaker miners are limited to trying to pare back costs, sell non-core assets and slow spending on new projects – a strategy that smacks to some of hoping that, once again, a rising gold price will offer salvation.

“The silver lining is that companies will have much cleaner balance sheets going forward. Now they need to change their model, reduce their size and improve their management and boards,” says Mr Beristain. “I am still not sure all companies have grasped this – or whether those that have are really believing it wholeheartedly.”

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Juniors: Fewer lines in the water slash hopes of a big catch

Waiting to meet investors at a gold industry conference, Darin Wagner has a succinct summary of the plight of many of the hundreds of junior gold miners – the exploration companies driven by hopes of striking it rich but whose chances of being funded have shrunk with the gold price.

“There’s a lot of turkeys that aren’t going to fly,” says Mr Wagner, chief executive of Balmoral Resources, a Canadian explorer that did manage to raise money in 2013. “It’s not much fun at the moment.”

In Toronto, a traditional venue for equity fundraising for mining, the number of new Canadian mining listings halved last year compared with 2012 while the amount of mining equity raised on the TSX Venture exchange was down 54 per cent. More than half of Canada’s 1,600 listed mining companies are in gold.

For big gold producers, a healthy junior sector raises the chances of gaining access to a significant project. “The more lines you have in the water, the more chance you have of catching a fish . . . no major gold miner can replace everything through exploration and you have to buy some production in, so we need juniors,” says Paul Rollinson, chief executive of Kinross Gold, one of the world’s largest producers.

The last company in which Mr Wagner was involved was sold for $420m to a bigger miner, a classic example of how the junior sector should work. “If you have had some success people will give you the ‘what if’ money,” says Mr Wagner. He suggests that companies such as his, exploring in Canada, will be favoured over those in more exotic locations.

“When times are good people are non-selective. When times are bad they need comfort food,” he says. “They come back to what they know – Canada, Nevada, Mexico.”

But the poor outlook for gold prices has brought many explorers to the point where they invoke comparisons with sentiment in the late 1990s following the Bre-X scandal, where the company claimed it had discovered the world’s biggest gold deposit in Indonesia. It was later found that the samples had been falsified.

“Post Bre-X was worse but this is a close second,” Mr Wagner says. “Gold explorers and producers are getting viewed with suspicion, rather than outright disgust.”

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