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That's what gold price will be in 2015, top analyst reiterates
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4th August 2006
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The supply of gold from South African mines has become increasingly constrained, resulting in a significant drop in the country’s contribution to global mine supply from 28% in 1990 to 13% last year. This is due to the fact that, since the 1970s, South African gold-mining companies have been confronted by a number of challenges, namely significant consolidation, escalating costs from mining at depths below 3 000 m and decreasing grades and gold prices, which has resulted in the decline in gold-mine production over the last 30 years. This situation was further exacerbated between 2002 and mid-2005 because of persistent cost pressures and a low gold price in rand-per-kilogram (R/kg) terms. Over this period, the industry has had to contend with a 37% decline in the gold price in R/kg and an above-annual-consumer-price-index (CPI) inflation on wages and consumables. Consequently, the continued profitability, and even survival, in the long term of the industry has been called into question. In response to this, Credit Suisse Standard Securities senior gold analyst Dr David Davis argues that the survival of the South African gold-mining industry depends on the continued replacements of depleted ore reserves by the discovery and conversion of new ore resources. This is the crux of the argument presented in Davis’s latest ‘Reserves and Resources’ report just released. In this report, Davis presents a comprehensive overview of South African and global gold production, as well as the status of South Africa’s gold-reserve base and the future outlook of the industry. Davis has held the position as one of South Africa’s top-rated gold analysts for a number of years and, having published numerous gold- analysis publications, is well positioned to comment on the state and future success of the industry.

SA production
In this report, Davis explains that South Africa produced 296 t of gold in 2005, which was down 13% on the 2004 production of 342 t. According to Credit Suisse Standard Securities records, Gold Fields was the biggest producer in 2005, with a local production of 2,82-million ounces, while both Harmony Gold and AngloGold Ashanti produced 2,57-million ounces.

Despite this significant decrease in production, Davis believes that South Africa’s yearly gold production will begin to moderate during 2006 and level out thereafter for the next three to five years at 300 t to 250 t. “Our rationale for this projection is based on four reasons,” elaborates Davis. “Firstly, the industry has just come out of a recession, which resulted in the industry’s having to adapt to the economic climate by cutting costs and restructuring its organisations. Therefore, the industry is now well placed to take advantage of the current and projected rise in the gold price. “Secondly, a 10% increase in the gold price over the next three years could increase South African gold reserves by around 5%.

“Thirdly, the new South Deep mine and AngloGold Ashanti’s new Moab Khotsong mine will be fully commissioned by 2009 and Harmony’s growth projects, Elandsrand and Doornkop, will also be nearing completion.

“Finally, the gold price in local currency has increased significantly over the past few years, which has had the effect of increasing margins, as well as extending the life-of-mine on some operations.” However, Credit Suisse Standard Securities studies indicate that the decline in South African production will resume in 2012, and reach between 200 t and 250 t by 2015.

Further, between 2012 and 2020, production by South African gold-mining companies will likely decline by around 20 t, or 650 000 oz, a year. This is due to the fact that many South African shafts are reaching a point at which radical downsizing is necessary. In addition, South Africa only has one growth project, the Western Areas-Barrick joint- venture (JV) South Deep mine, whereas the other projects that are currently being under- taken by the gold majors will, essentially, replace existing production. Consequently, Davis argues that the replacement of reserves is essential to the sustainability of South African gold production in the long term.

Replacement of reserves
The foundation of Davis’s argument is that, while the survival of the South African gold- mining industry depends on the continued replacement and growth of reserves, this process is not being undertaken fast enough by the majority of local mines.

According to Credit Suisse Standard Securities calculations, South African reserves and resources currently stand at 161-million ounces and 842-million ounces respectively, with the ratio of resources to reserves standing at 80:20.

South Africa’s resources and reserves represent around 39% and 13% of the global resource and reserve base respectively. The distribution of reserves and production between the gold majors in South Africa is Harmony 32%, Gold Fields 29%, Western Areas-Barrick JV 19% and AngloGold Ashanti 17%. Since the 1970s, Credit Suisse Standard Securities calculates the decline in reserves has averaged around 375 t of gold a year, which is equivalent to 13-million ounces of reserves. However, Davis argues that the industry is rapidly approaching a crossroads with regard to dwindling reserves. The industry is capital- intensive and will require huge capital inputs and high gold prices to replace current reserves and maintain production, as much of the known resources lie at depths below 3 000 m. Davis cites the Western Areas-Barrick JV at South Deep as an example of the magnitude and timing of these capital inputs. “This mine took around 19 years from inception in 1985 to commissioning in late 2004. “Shaft sinking down to 3 000 m started in 1995, taking some 11 years to complete. “The capital cost of the mine when fully equipped, including the metallurgical plant, but not fully developed, was R4-billion,” says Davis.

Without the replacement of reserves, Davis argues that all the South African gold majors will experience a significant fall in production after 2013. AngloGold Ashanti’s recovered gold profile shows a steep drop-off in production at a rate of around 300 000 oz/y after 2013. AngloGold Ashanti’s Moab Khotsong mine is the company’s only ‘new’ South African mine that will come on line in the near future. The life of this mine should be extended with the reinclusion of the Moab Khotsong phase two, equating to 4,1-million ounces, if favourable economic conditions prevail. Gold Fields’ recovered gold profile shows a steady decline in production at around 45 000 oz/y until 2013; thereafter, the decline increases at a rate of around 450 000 oz/y. The rate of fall-off in production is greater than that of AngloGold Ashanti, mainly because Gold Fields has three mines in South Africa of similar age, while AngloGold Ashanti has eight mines of varying ages. Gold Fields is currently investigating extending the life-of-mine at Kloof and Driefontein to access around 10-million ounces in total. In the long term, Gold Fields could also exploit the 10,9-million ounces in the Elsburg Area at Kloof. Harmony’s life-of-mine is expected to remain fairly constant until 2013.

The company’s growth projects at Elandskraal and Doornkop, the Tshpong decline and Masimong expansion projects will extend production and slow the rate of decline in the future years. Harmony’s recovered gold profile shows a drop-off at a rate of around 160 000 oz a year after 2013. Should favourable economic conditions prevail, Harmony could exploit the Rolspruit and Poplar projects that contain some 6,7-million ounces and 3-million ounces respectively. In the long term, Harmony could also exploit Target North, which has 67-million ounces of indicated and inferred resources. However, Davis argues that renewed and increased focus on exploration of South Africa’s gold deposits is essential to facilitating the replacement and, more importantly, the growth of reserves.

Exploration
Much of the exploration of South Africa’s gold deposits was done in the early part of the twentieth century and was primarily dominated by the major gold companies.

Consequently, a junior gold-exploration sector was not able to flourish during this period, which has resulted in a noticeable dearth of exploration companies in the twenty-first century, at a time when exploration has become vital for the survival of the industry. In addition, most of the gold majors have not pursued an active programme of exploration for a number of years, as this activity can be time-consuming and costly. Davis elaborates that an exploration programme culminating in a successful feasibility study, which can take at least five years, has a chance of only around 1 in 50.

Given the dearth of new exploration projects, many companies are moving through a geographical-consolidation phase, consisting of mergers and acquisitions, as well as forming strategic alliances with neighbours to take advantage of economies of scale.

However, Davis believes that all is not lost, as the local gold industry has seen new entrants on the exploration front. The most notable example is Wits Gold, established by Adam Fleming in 2003. To date, the company has acquired, as part of agreements with AngloGold Ashanti, Gold Fields and Harmony, significant resources in the inferred category of 142-million ounces of gold. However, this process could take up to ten years, which means that Wits Gold has, effectively, taken a long-term option on gold. In addition, Davis believes that the development of new deep-level mines in South Africa will likely go ahead through a consortium of mining companies because of the significant capital costs and time required to develop them.

Future of gold
Davis argues that, while it is evident that South Africa’s reserve base is rapidly dwindling, an upward trend in the gold price for the foreseeable future will likely mitigate the downward trend in reserves. Credit Suisse Standards Securities studies indicate that gold supply is falling behind demand as the diminishing number of new reserves fails to compensate for dying mines, worldwide. “This has been happening for some time but, until recently, the effect has been masked by central-bank sales and producer hedging,” says Davis.

“However, central-bank sales will likely whither, and these banks could become net buyers of gold.

“This transition, together with expected increased investment demand, jewellery consumption and diminishing mine supply, will be when the supply-demand imbalance heatsup the gold price.” Davis adds that between 2007 and 2010, supply-and-demand dynamics will undergo irreversible change, caused by a decline in global mine and official sector supply and increased demand from China and the investment community. “Following on from our gold-price forecastin 2005, we still see a gold price of $700/oz,$800/oz and $1 200/oz by 2008, 2010, and 2015 respectively,” concludes Davis.
Edited by: Jade Davenport

 

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