"Whoever has the gold makes the rules." This old saw used to give me a little laugh and a little longing to own a gold mine. Now there is a new reality and a new rule: "WHOEVER HAS THE GOLD WILL BE LUCKY TO MAKE A PROFIT." It is a situation that does not favour producers.
First, let's look at the price of gold, which hit a 17-year high this week. The London fix was US$470.00/oz on the morning of Sept. 20, or about Cdn$550.00/oz. At first glance the news looks good, but remember these prices are in current dollars. The London fix early in January 1988 (just over 17 years ago) was US$483.90/oz or Cdn$628.59. And when we take inflation at 2.34% a year into account, it would cost Cdn$931.08 in today's currency to buy the same goods and services that an ounce of gold bought in 1988.
The effects of exchange rates and inflation paint a gloomy picture for gold miners. Add to that higher production costslabour, environmental compliance, licensing requirements, equipment and servicesand readers will realize that producer budgets are frequently stretched to the breaking point. (See item about Mining Chemicals, below.)
Small producers are already feeling the pinch. Toronto-based RIVER GOLD MINES announced this week it is tightening its belt. "In light of soaring costs and unfavourable exchange rates affecting the industry, management has completed a comprehensive review of mining operations and opted to pursue a defensive strategy until economic conditions improve," according to its press release. This "defensive strategy" involves a 50% production cut to 36,000 oz/year, exploration drilling and a recalculation of reserves at its Eagle River mine near Wawa, Ontario. Thankfully, the mine remains open.
Vancouver-based KIRKLAND LAKE GOLD is another small producer trying to remain upbeat in difficult times. It produced 45,865 oz of gold from its Macassa mine in Northern Ontario in the year ended April 30, 2005, and lost a little over Cdn$28 million in the process. The company lost another Cdn$5.4 million in the most recent quarter, despite head grades of 0.40 opt. Kirkland Lake has begun an aggressive program to deal with labour shortages, excessive dilution, productivity shortfalls and mechanical problems with its underground mining equipment. The company remains optimistic that its 2006 target of 90,000 oz can be met by developing three new mining levels and the rehabilitation of the 5700-level loading pocket.
My intent is not to frighten investors away from these companies. The management of the firms are simply stating publicly what has become a new reality for the gold mining industry: rising prices must be weighed against rising costs. The ability of these corporate leaders to react to the new golden rule is a measure of these companies' well being.
I urge our readers to remember that high commodity prices are not a panacea for our industry. The profitability of mines is dependent on a multi-faceted reality.