By Jackie Steinitz
There was good news and not so good news for gold producers in the presentations at the GFMS precious metals seminar in London last week.

On the plus side GFMS, the precious metals research and consultancy group, anticipates that the gold price, which already attained an all-time half-year record of $658 per ounce in the first half of this year, will remain high for the rest of the year, buoyed by investor demand and gold’s safe haven status.

Last week, at the time of publication of the update to the Gold Survey 2007, GFMS were expecting the gold price to average $690 in the second half of 2007, which would imply a full year average of $674 per ounce, up 12% on 2006 (see the RI article "Bullion Bull Run: Gold's Rally Expected to Continue to 2008" for more details).

On the downside, however, the industry has faced substantial cost increases over the last year; total dollar cash costs in the first half of 2007, at $371 per ounce, were a hefty 21% higher than a year ago. And according to William Tankard, senior metals analyst at GFMS, who presented an analysis of costs and margins at the seminar, there is no let-up to cost pressures in sight.

Nonetheless the simple cash margin - the difference between the total cash costs and the spot gold price - averaged $287 per ounce in the first half of 2007, not far off the 25-year high of $323 per ounce attained in the second quarter of 2006.

Tankard’s analysis is based on GFMS’ rigorous database of the quarterly costs from 200 mines operated by 90 companies, which together produce around 14,00 tonnes of gold annually - around 55% of the world market. The remainder is accounted for by mines where gold is a by-product, artisinal production and Eastern bloc or Chinese output.

According to Tankard margins in the industry were low but steady from 1997 to 2001. Since 2002, however, costs have been on the rise, rising by an average of 15% per annum, driven by above-inflationary rises in:

Labour costs: which typically account for 20%-40% of total costs where there has been intense competition for both skilled labour and managerial staff. In Western Australia, for example, the unemployment rate is now less than 1%.
Energy costs: which generally represent some 20%-30% of costs.

Consumables: such as steel, explosives, cyanide and tyres, which account for the balance of the costs and which are typically quite dependent on energy costs.

Fortunately for the producers, the 15% per annum cost increase over the last five years has been exceeded by the 18% per annum increase in the spot gold price, which has allowed margins to soar, though for some producers the margins have been tempered by:

The impact of exchange rates: which have particularly hit the Australian producers over the last year as the Aussie dollar has appreciated by some 10% against the greenback.

Producer hedging: which has resulted in an average realised price below the spot price.

The curve in the chart to the right shows GFMS’ estimates of the current cost curve for total cash costs (which include all cash operating costs plus royalties and production taxes but exclude depreciation, amortisation and any reclamation or mine closure costs).

While the median cost is $370 per ounce, there has been an enormous variation around the average. Some mines have enjoyed negative total cash costs because of substantial by-product credits, with silver and copper the most common by-products in gold mining - though uranium and zinc can also be significant, while the most expensive 2% of production is in marginal mines where the total cash cost has been above the spot price.

Tankard highlighted a number of routes being taken by companies to mitigate the effects of rising costs, including some examples of industry consolidation to benefit from potential synergies between operations, hedging on forex or energy prices and/or the construction of power plants on some mines in order to avoid national grid energy charges.

Outlook

Looking ahead, Tankard anticipated that costs would continue to climb relentlessly in the near term with energy prices remaining elevated while staff shortages would remain an issue. Mines outside the dollar bloc would continue to be affected by dollar weakness.

However, producers would continue to benefit from high gold prices while the slimmer producer hedge book after the sell-off in the early part of the year will enable producers either to sell at higher spot prices or to return to producer hedging but at higher prices. Tankard’s conclusion was that margins were likely to be maintained in the medium term at boom levels.

His prediction has certainly got off to a good start. Since the presentation five days ago, the spot price has risen $19 per ounce and it is $45 up on a fortnight ago, while gold futures have risen to a 27-year high today after the Fed cut interest rates for the first time in four years by half a percentage point.

By Arrangement with www.resourveinvestor.com

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