By Ivan Y
While perusing the 2015 outlooks given by many gold and silver mining companies in the past few weeks, one trend that I noticed is that mining costs this year are generally expected to drop compared to last year. This is not true in all cases. Eldorado Gold (NYSE:EGO) is a good example of a miner that is expecting higher costs in 2015. But, generally-speaking, costs are trending lower. Here are a couple of examples:
- First Majestic Silver (NYSE:AG) had an average all-in cost of about $19 per silver ounce in the first three quarters of 2014, but they expect that to decline to a range of $13.96 to $15.48 in 2015.
- Goldcorp (NYSE:GG) had all-in sustaining costs of approximately $950 per gold ounce in 2014, but they expect costs to fall between $875 and $950 in 2015.
A reduction in mining costs is great news for the mining industry and for mining investors. After years of excessive spending, companies have finally started to pay attention to cutting down costs in response to the bear market in gold and silver. Exploration expenses have been cut back, costly development projects have been deferred, sustaining capital investments have been cut, and staff has been reduced. Some miners have also shifted towards mining high-grade ore during this downturn. Lower oil prices, especially for diesel, will also contribute significantly to lower mining costs this year.
All of this good news for the miners is bad news for investors in iShares Silver (NYSEARCA:SLV), SPDR Gold (NYSEARCA:GLD), or other forms of the metals. One of the arguments that precious metals investors have made in the past two years is that the metals can't go much lower because they are already at or below the cost of production. And to some degree they were correct because gold's low mark of $1140 set in November was only slightly lower than what many believed was the average cost of production in the industry:
- According to Citi, about 75% of gold miners have all-in costs slightly below $1,200.
- The gold mining industry as a whole does not generate free cash flow below $1300.
- "The industry has geared itself around $1,200 ... If it falls below that level, then there are a lot of mines around the world that are really going to struggle." (Joseph Foster, Van Eck Global)
Silver's low mark of $15.30 in this bear market was actually significantly lower than what was believed to be the cost of production. For example, in 2013, David Morgan of silver-investor.com suggested that the average production costs for silver was about $20.
The cost of production, however, for both gold and silver has been lowered and thus no longer can one make the argument that gold can't drop below $1200 or $1300 because that is no longer the breakeven point. This is similar to one of the arguments that Goldman Sachs made when they predicted that gold would drop to $1000 by the end of 2016. I think the current breakeven point for the gold industry could be at least $100-200 lower than $1200-1300. For silver, I think the breakeven point is much lower than $20 now. When I look at the 2015 guidance for primary silver producers, I don't see any company expecting to have costs as high as $20. Most expect all-in costs to be in the low to mid-teens.
All-in vs. Cash Costs
A fallacy that some make is assuming that the price can't drop below the average all-in production cost. Actually, it should be the average cash cost that they should be looking at. The all-in cost includes expenses such as development costs that have already been paid for. It's only if the price drops below the cash cost that a miner would consider halting production. The difference between the cash cost and the all-in cost can be large for some miners. Pan American Silver (NASDAQ:PAAS) is a good example of this situation. The all-in cost in Q3 2014 was $20.50 per ounce, but the cash cost was only $12.29. I don't think PAAS would even consider shutting down operations unless silver drops to the low teens.
Also, even if the price drops below the cash costs, it may make more sense for the miner to keep operating at a loss for a short period than to shut down a mine and put it on care & maintenance. Shutting down a mine and restarting it later involves a lot of costs. It also may be devastating for the local mining communities of lesser-developed countries. A sensitive management team with good relations with the community may be reluctant to harm the community.
The decision by mining executives to be more frugal is a catalyst for lower precious metals prices. Lower oil prices should also be seen as a catalyst for lower precious metals prices. However, I believe that these catalysts should only impact prices negatively in the short-term, which I define in this article as several months or a year. In the long-term, cutbacks in exploration and investments will reduce future supply, but that is a scenario that could take a few years before realization.
I expect gold and silver prices to head higher in the long-term, but lower mining costs are a headwind in the short-term.
Disclosure: The author is long SLV, GTU, CEF.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.