DOING SOME DIGGING Costs take glitter out of gold mining

The price of gold is enjoying its longest sustained rally in 30 years. It has climbed steadily from US$275/oz in Ja...
The price of gold is enjoying its longest sustained rally in 30 years. It has climbed steadily from US$275/oz in January 2001 to its present level in the US$425-435/oz-range. The strong price begs the question: Where is the matching rise in gold mining profits?

Granted, many Canadian companies have experienced growth as the gold price rose. According to the website, in the last three years net AGNICO-EAGLE has increased its revenues 24.86%, BARRICK GOLD 12.08%, CAMBIOR 14.92%, GOLDCORP 5.02% (before the merger with Wheaton), KINROSS GOLD 27.18%, PLACER DOME 14.72%, and WHEATON RIVER an astonishing 252.56%.

On the downside, only some of these companies had profitable years. In 2004, Agnico-Eagle had a net income of US$47.88 million, Goldcorp US$51.35 million, Placer Dome 291.0 million and Wheaton River 143.12 million. Barrick, despite a year-over-year growth in revenues from mining operations of 48%, had a net loss of US$102 million.

Barrick has spent lavishly on capital projects. Its plan to develop five new mines in five years and the needs of its existing mines, forced Barrick to make capital expenditures of US$824 million in 2004, up roughly half-a-billion dollars from the previous year.

Barrick was not the only producer to feel the pinch. Canadian, Australian, Latin American and South African miners are feeling the effects of a weakening U.S. dollar. Since January 2, 2003, the exchange rate for Canadian to U.S. dollars has improved from $0.635 to $0.806 or 27%. Other currencies have also strengthened: the Australian dollar is up 37%; the Chilean peso is up 24%; the Peruvian new sol is up 8%; the South African rand is up 37%; the euro is up 26%. Even the Russian rouble is up 15% against the falling U.S. dollar. Because gold is priced in U.S. dollars, producers whose local currencies are getting stronger are receiving less in terms of local currency for each ounce sold.

Operating costs are rising, too, driven by higher prices for equipment and supplies. CMJ is aware that structural steel has taken a jump in Latin America and there is a global shortage of tires for large haulage trucks. The escalating price of a barrel of crude oil is felt not only by mines but also by their employees when they fill their family vehicles. Wages, as expected, continue to rise. The upward pressure on cash costs was evident a year ago, and during 2004 it increased. One estimate put the average increase for all producers around the world at 13% last year, making it more than US$250/oz, and I would expect that is on the conservative side.

These gloomy figures add up to very tight profit margins for even the biggest and best-managed gold miners. Juniors and companies on shaky financial footing might not succeed even with high gold prices. Already some smaller players have had to postpone their mine plans in the face of rising development costs and a shortage of equipment.

The strong price of gold is encouraging, but it is only part of the story. A closer look reveals that the profit margin on getting an ounce out of the ground and selling it, will be the true measure of the successful gold producer.


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