TORONTO (miningweekly.com) – Only about 60% of potential new gold supplies are incentivised for a 12% internal rate of return, at a gold price of $1 300/oz, Wood Mackenzie (WoodMac) analyst Vince Madden-Scott told an audience during a recent mining convention, in Toronto.
This spells a grim picture for an industry that is expected to see peak output this year, as reserve attrition bites and sends the industry into a potential structural decline going forward.
The Australia-based analyst pointed to the cutbacks to exploration programmes in the bear market of 2011 to 2015 that led to the dramatic reserve attrition the market is experiencing today, compounded by a weak global project pipeline holding very few Tier 1 discoveries. This is a direct result of the chronic underspending on exploration and a focus on brownfield initiatives.
Further, the gold market is seeing mature market participants such as South Africa, and to a lesser extent Australia, entering a structural decline, as their mines become deeper, more remote, with lower grades and greater operational complexities.
"Reserve attrition is an underlying threat. The miners cut exploration in a time of crisis to preserve margins. Many companies high-graded resources, which was counter intuitive because of the finite nature of mining. We expect to see a significant and sustained production decline going forward as a result of the decline in exploration budgets," Madden-Scott said.
He noted that the average gold mine life had fallen from 14 years to 11 years since 2012, with a relative lack of quality in the project pipeline to blame for this. "The pantry is all but empty, save for a few highlights."
Between 2017 and 2022, Canada is expected to lead in global gold production growth, which is directly correlated to its successful exploration incentive schemes and strong regulatory framework, that helps to underpin exploration. It will grow to become the second largest gold producer by 2022, after China, adding 80% or 153 t/y of gold to bring its production profile to about 350 t/y of yellow metal.
Contrasting this to dramatic effect is Tanzania, whose gold output is expected to contract by 67%, or 37 t, to somewhere around 20 t/y. This, he noted, is a good example of what can happen "when regulations go askew".
WoodMac saw industry-wide cost escalation through 2017 make a comeback for the first time in years, which was mainly driven by inflationary pressure and mine site costs. Compounding this were the higher cost curves of traditional mining jurisdictions such as South Africa and Australia, who sit in the upper quartiles of the cost curve.
Madden-Scott noted that the world's miners are making healthy margins at the current gold price, but reminded the audience that the gold price is locked in step with costs. If the gold price rises, costs tend to rise too.
He said that many industry participants and observers have argued that this trend will not happen this time round, since miners have learnt from their mistakes of the past. "We'll see," he quipped.
Further, he sees ongoing geopolitical instability and market turmoil potentially providing support to the gold price in the short to medium term. Protectionist measures, such as tariffs mulled by the US, will likely create market instability and could precipitate a trade war.
The forecast contraction in global gold supplies over the coming years may support higher prices and the creation of a Spot Gold Exchange in India will likely stimulate subcontinent demand and improved liquidity.
On the downside, strong economic growth in the US generally leads to inflation and a stronger greenback, which is traditionally bad for the gold price. Madden-Scott also pointed out that hawkish federal policy and higher interest rates in the US will likely translate to higher yields on bonds, placing downward pressure on the gold price.
Further, demand driven by gold-backed exchange-traded funds such as the Van Eck fund has slowed considerably in 2017, despite registering net inflows.
Interestingly, Madden-Scott noted that the current global geopolitical instability appears to be fully priced into today's gold price.
"Geopolitical instability is a key driver and sustainer of gold prices, but in recent years, it has not really affected the price outlook. We believe the median outlook is $1 300/oz as these things are already priced in," he said.