As a result of the gold price dropping to below $1 100/oz, global energy, metals and mining research consultancy group Wood Mackenzie predicts that almost 40% of gold project production capability will be uneconomic and this will lead to a significant cut in future supply.
“Following the recent announcement by the Chinese central bank of a seemingly underwhelming 57% increase in gold reserves, the gold price plunged to below $1 100/oz amidst a broader commodities sell-off. These price levels put about 10% of gold miners in lossmaking territory,” says Wood Mackenzie senior research analyst Dr Ryan Cochrane.
He notes that major gold miners are struggling to replace reserves, which means that production may begin to decline and higher prices will be required to justify the next round of large capital expenditure (capex).
Against this challenging backdrop, he adds that gold producers have reacted by implementing a number of value realisation measures. These include the producers only developing projects which meet stricter internal rate of return targets of between 10% and 15% throughout the metal price cycle; slashed capex budgets and active cost cutting to free up cash flow in the metal price downturn.
“With this approach and despite the challenges outlined, the gold sector may be poised to start performing more in line with the historically more successful copper sector,” Cochrane points out.
Within the copper sector, producers remain committed to divest noncore assets, slash expansion capex and free up cash flow to return to shareholders, he states.
“For copper miners, a conservative managerial approach to capital allocation meant that project development was financed largely through internal cash flow, while equity and debt financing was used relatively sparingly. Gold miners, however, aggressively pursued production growth and hedged significant portions of their production at relatively low gold prices effectively missing large portions of the gold market bull-run,” Cochrane explains.
Moreover, he adds that the quest for production growth – especially in the latter portions of the bull market – meant that many gold miners developed increasingly marginal projects and paid excessive premiums for acquisition-driven production growth through the extensive use of debt and highly dilutive equity financing.
This has been compounded by gold mining companies maintaining large dividend payments, despite recording cumulative net losses over the period, with payouts funded partly through external financing.