The CEO of AngloGold Ashanti, Mark Cutifani, recently gave an excellent talk at the July meeting of the Sydney Mining Club. Everybody should hear Mark’s talk “Importance of Mining to Global GDP”, even people with the remotest interest in mining. Henry’s readers can see Mark's talk delivered here: www.sydneyminingclub.org.
For those stretched for time, here a few snippets. Measured in terms of sales revenue, mining contributes 11.5% of GDP. When indirect components like services are added the share increases to 21-23%, and when fertilizer and other industrial minerals are added, the contribution soars to 45%. Yet the surface of the world disturbed by mining is LESS THAN ONE PERCENT. No doubt the Tassie Greens would like to ignore such a figure in addition to the facts that mining uses less than 1% of potable water, and produces less than 3% of carbon gases.
Everyone that the Raff has talked with concerning the Australian Mining Industry Council agrees that AMIC has done a lousy job portraying Australia’s mining industry; the appalling effort has been going on for years. It should not take stirring by a boy from Wollongong to paint a picture that should have been promoted heavily yonks ago.
Now let’s turn to costs, which for several years have displayed a CAGR of 10-15%. It is not just the gold producers facing steeply rising costs but the whole mining sector. Cutifani sys that gold grades are falling, mines are deepening and margins collapsing. AngloGold recently reported total costs, before interest and tax of US$1,280 per ounce. The current margin with gold trading at US$1,600/oz cannot be sustained medium- to long-term.
The Raff had cause to look closely at a couple of Aussie mid-tier gold producers with cash costs, including capitalized mine development costs of between $A1,200/oz and A$1,500/oz ounce. These operations are struggling for survival and in a perfect economic environment would already be on care and maintenance; but instead are treading water waiting for the price of gold to rise before destroying shareholder value. A director of one company forecast one third or more of Australia’s gold mines to close within 2-3 years if the gold price remains around US$1,600/oz and costs keep rising apace.
So what’s happened? Over four years at one operation, fixed costs have risen from $A105,000 per month to $A450,000 per month on top of hikes in variable costs. And it is not just labour costs that have soared 40% over recent years but so to has the cost of consumables. For instance the domestic price of steel balls used in grinding mills increased from $A1,300 to $A1,700 per tonne. The miner switched to importing steel balls from China costing $A900 per tonne plus an extra $A100 per tonne for freight and the quality is good.
Current cost pressures are overwhelming but the industry is fighting back. New cost management systems are being introduced and the squeeze is being put on service providers like power and laboratory assaying services. All down the chain industry participants are being squeezed so collective earnings before tax is falling. Guess what is going to happen to Labor’s budgeted surplus? But the Raff Report forgot that we are blessed with the world’s greatest treasurer. Perhaps it was not surprising that the polls have lifted in favor of Labor by 5 points to 33%, but when the September quarter power bills are many weeks ago let's see how popular Labor is.
Strongly related to the resource sector are the vast numbers of small stockbrokers that survive on writing tickets and capital raisings. Whilst it is still possible for companies with extra good stories and management to raise capital, the door is effectively closed for the multitudes. Recently the Raff was showed the turnover figures for May for some 80 stockbrokers in Australia; yep that’s right around 80 of them. If the market does not improve by year-end 30 names at least should disappear from the list.
There have been countless articles in the press over recent times citing falls in the prices of iron ore, coking and thermal coal. In a nutshell, low gas prices in the USA have caused some power stations to switch fuel source from coal to gas. The response of some coal miners was to dump thermal coal in the European market. Coal exported to Europe from the USA has displaced coal from South Africa. In turn the South African producers have dumped coal into the Asian market, Australia’s backyard. If this situation continues long-term, given that production costs are soaring, many Aussie thermal producers will face mounting operating losses and they sure as hell will not be liable to pay tax. The FOB cost for the smaller producers of thermal seems to be around $A70/t or thereabouts, making for an uncomfortable margin with thermal coal falling towards US$80/t.
Troubles in the coal industry are coming home to roost. The Raff was recently told that around 90 geologists from two consulting companies were recently made redundant. The Raff believes that most of these geologists were involved in the coal and gas industries, and that layoffs are probably, at least in part, related to one the biggest coal miners telling line managers costs must be cut by 30%.
Unfortunately Labor does not seem to care about job losses. In fact in a radio interview on the ABC there was a comment from a Government spokesperson that hundreds of jobs lost when a business collapsed were irrelevant because they only represented a tiny fraction of the workforce. What will that person say when thousands are made redundant from mining and finance? Every thinking person knows that the real employment rate is much higher than the official estimate. Why doesn’t the Government use the people registered with CES as a guide?
The price of iron ore has fallen, largely because of weaker demand from China, where odds on, the economy is more likely much weaker than assumed by many. However, the margin is still huge with the highest cost producers of iron ore in Australia having FOB cash costs a tad below US$60 per tonne against a price that recently slipped below US$120 per tonne. But it should be noted that at least one large investment bank is tipping the price of iron ore fall below US$80 per tonne over the next couple of years. If that happens, the tax collection will move south faster than the crowd at DJ’s annual sale.
The Raff is surprised by the lackluster performance of gold, which incidentally has outperformed equities by a country mile. The poor performance by gold stocks is largely explained by their price earnings multiples. At the start of this decade, most of the leading gold names traded on PERs of plus 20X. This was a crazy situation given that large cap miners with solid and rapidly rising cash flows traded on multiples of about half the gold sector. What has happened is that the gold sector PERs have fallen or been compressed to more reasonable metrics. But this still does not make gold stocks cheap; after all, as a sector, is not generating free to either pay a dividend or lift a dividend payment.
Not surprisingly, return on equity and invested capital is mostly miserable for the gold sector. There is of course, industry pundits claiming that now is the time, straw hats in winter stuff, fill your boots and get ready for takeoff. The Raff is not quite sure about that idea because as the gold industry is today its pretty well stuffed. The Melbourne Mining Club recently hosted Nick Holland, CEO of Gold Fields Ltd. This was another excellent presentation and investors interested in gold miners and how the industry has failed miserably to achieve any satisfactory benchmarks should read about it here: www.goldfields.co.za/.
Remember the words of Arthur Holmes, an eminent geologist who said: “to reason without data is nothing but delusion”. Unfortunately what data there is for the gold sector is awful. The gold sector will rationalize through mergers and takeovers, like Silver Lake buying Integra that is currently in the news. This was great news for Integra (ASX: IGR) with share price up 27%, but not so good for Silver Lake Resources (ASX: SLR) with a share price fall of 8.5%.
The Raff is heading to Hawaii today to inspect the volcanoes and have a jolly time. Much has changed since he was last there as a participant in the Hawaiian Iron Man Triathlon in October 1987. One thing that won’t change in his absence though will be the ridiculous volatility that stalks investors. The Raff still has his dosh in cash in the bank, but after reading John R Talbott’s book The 86 Biggest Lies On Wall Street (well worth a read) sees no overwhelming argument to change strategy, except to stuff cash into a large home safe.
Talbott seems to have a good track record; he predicted the housing crash in 2003 in his book The Coming Crash in the Housing Market. In the first mentioned book, Lie #47, 'Gold is a bad investment because it has few productive uses in industry'. Talbott likes gold as a hedge against inflation because supply is relatively flat and vast printing of currencies destroys value of paper money.