The gold mining industry is undergoing substantial, fundamental changes that do not bode well for the future of the sector. Or rather, they place the future in considerable doubt.
These changes, which we'll outline in more depth below, are a direct result of the prolonged period of low prices for gold and the precious metals generally. Dwindling metal prices—and profit margins for the miners—have led to a handful of unsustainable solutions.
"Half Not Viable"
According to the CEO of Randgold Resources Ltd. (NASDAQ:GOLD; LON:RRS), Mark Bristow, perhaps as much as half of the gold output coming from major mines right now is being produced below profitable levels. That is to say, if these companies sell their gold production as current prices, they are eating a loss on about half of their output due to the cost of extracting the metal.
This is partly because the built-in costs (overhead) associated with these operations were reckoned well in advance. Gold mining is a slow, long-term venture that requires patience. Plans and costs must be covered ahead of time, and the final product isn't separated from its ore and ready to sell until potentially a year or years down the road.
How Miners are Coping
In order to offset lower prices, gold producers have been employing a pair of strategies: 1) pumping as much of the yellow metal as possible and 2) high-grading their ore. The first trend is self-explanatory; the second, "high-grading," means that miners are extracting the best (purest) deposits first, quickly eating into how much gold the mine will produce over its lifetime.
Moreover, ramping up production has the effect of suppressing prices (flooding the market with extra supply), exacerbating the already-low price levels.
“The more we continue to produce unprofitable gold, the more pressure we put on the gold price,” Bristow remarked in a recent interview. In other words, if miners could withstand the hits to their bottom line in the short-term, holding back some of their current production would be supportive of higher gold prices.
“In the medium term," he continued, "[this development is] a very bullish outlook for the gold industry. The question is, how long are we going to supply it with unprofitable gold?”
Randgold stands out in the industry with annualized returns of 19% this year on London's FTSE 100. Most have not fared nearly as well.
Fork in the Road
Bristow had another insight: "The industry has moved away from looking at optimal life of mines because everyone is trying to demonstrate short-term delivery,”
What Randgold's Bristow is expressing is a fork in the road where mining companies must make a choice. They must either high-grade and increase output to stay afloat in the short-term, or weather the storm and cut production in the hopes of better future market conditions and sustainable operations. This choice is largely dictated by the financial state of the firm; even some of the largest firms have taken on too much debt to wait things out and must sell their gold now to pay their bills.
Bloomberg notes that, in general, consolidation (i.e. mergers and acquisitions) has been the answer when this conundrum has emerged in the past. Whether such a concentration of mining assets proves effective will remain to be seen.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.