TORONTO (miningweekly.com) – The mining industry is currently restoring operating margins and free cash flow (FCF) at the expense of production growth, while the global gold supply is flattening, with significant mine closure risk should the metal venture below the $1 200/oz mark, Sentry Investments senior VP and senior portfolio manager Kevin MacLean told investors, in Toronto, on Tuesday.

He said that while mine closures had started, the global supply was also diminishing, with the significant liquidation from the exchange-traded funds (ETFs) now nearing the end and Chinese and Indian gold scrap exports being zero.

Compounding the looming supply plateau, MacLean said, was the fact that gold demand was expected to reach a record in 2013. Global demand totalled 2 533 t during the first half of the year.

He said the gold price was destined to find support, should the continued ETF liquidation not continue to offset reduced scrap output.

MacLean said that China was taking advantage of the current down cycle as the government and citizens were building their gold investments. He noted that China wanted its yuan to rival the US dollar as a global reserve currency, and would be able to effectively do that by buying only six year’s worth of global gold output.

In fact, so strong is the current Chinese demand that it was at twice the peak Indian demand, and comprised about 55% of global gold mining output.

He expected India’s historically strong demand for the yellow metal to stabilise well above the current depressed levels, noting that it could only get better from the current near-total absence of imports.

India had restricted shipments and increased taxes to contain a record current-account deficit and halt a plunge in the currency.

TEETERING ON THE BRINK

During the second quarter, about 25% of 67 gold-producing companies, representing roughly 44% of worldwide gold output, were in negative FCF territory, before development capital expenditure (capex), Sentry portfolio manager Jon Case told the audience.

This meant that those companies’ all-inclusive sustaining cash costs were higher than the second-quarter average gold price of $1 427/oz.

FCF represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. It is critical because it allows a firm to pursue opportunities that could enhance shareholder value.

All-in cash costs include total cash costs, capex, exploration expenses, corporate general and administrative expenses and cash taxes paid.

Of these companies, Lipper Fund award-winning Case said about 80% were overspending their cash flows in the second quarter.

He pointed out that miners were, in recent months, mainly preoccupied with margin relief, especially during the third quarter, as companies battled to reconcile the lower gold price with cash costs.

Gold was on Wednesday trading at $1 284.40/oz on the spot market in New York, after falling to $1 200/oz on June 27.

Case said that there was historically a lag of about a year between production costs and gold price fluctuations, pointing to input costs of cyanide this year already declining by about 40%, tyres being down 30%, drilling costs falling 25% and that of labour, consulting, contractors, and general and administrative also being on a down trend.

He also pointed out that as a result of the lower gold prices, miners had slashed the estimated global gross gold output growth to 2016 by almost half.

Of the just-less-than-35-million-ounce output expected in 2016, as forecasted in January, less than 23-million ounces remained on companies’ organic growth plans by September.

This was impacted by 25 announced mine closures, taking about 1.05-million ounces, or 1.1% of global output in 2012, off the market; three depleted mines, taking out 385 000 oz, or 0.4%, of 2012 global output; and 15 mines being at a high risk of closure at current low prices, which could take out about 3.58-million ounces, or 2.3%.

In fact, the annualised mine output was down 2.1% in the first half of 2013, over the first half of 2012.

Case pointed to large gold miners not being particularly hot investment options at present, as they were challenged to replace production organically, resulting in no growth on a per-share basis.

However, despite limited growth opportunities, large gold miners still attracted premium valuations when compared with smaller producers, despite many of them having negative FCF yields, whereas several smaller producers posted FCF yields well into positive territory. FCF was virtually nonexistent at large gold mining houses.

Meanwhile, global silver output was expected to rise through to 2017, mainly on the back of increasing by-product output, but also owing to primary silver production. Global silver output was expected to total just under one-billion ounces in 2017.

He noted that in spite of the current difficult markets, investors should not expect silver mine closures, owing to about 55% of primary silver producers’ all-in sustaining costs being well under the average expected 2014 silver spot price of about $24.24/oz.

From an investment point of view, gold and silver roughly follow the same trends despite gold trading at about 60 times the average silver spot price. However, silver is much more prone to volatile price fluctuations, which for some spell trouble, but is for speculators exactly the wildcard drawing them to invest in the grey metal.